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George Westerman
Richard Hunter

IT Risk
Turning Business Threats
into Competitive Advantage

Harvard Business School Press


Boston, Massachusetts

Excerpted from IT Risk by George Westerman and Richard Hunter. Copyright George
Westerman and Gartner, Inc. All rights reserved. Harvard Business School Press, June 2007.
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Introduction
IT Risk and Consequences

A HALF CENTURY of adopting information technology at


an astonishingly rapid rate has created a world in which
IT is not just widely present but pervasively, complexly intercon-
nected inside and outside the enterprise. As enterprises’ dependence
and interdependence on IT have increased, the consequences of IT
risk have increased as well. What is IT risk? It’s the potential for an
unplanned event involving a failure or misuse of IT to threaten an
enterprise objective—and it is no longer confined to a company’s IT
department or data center. An IT risk incident has the potential to
produce substantial business consequences that touch a wide range
of stakeholders. In short, IT risk matters—now more than ever.
This change in the meaning and importance of IT risk has caught
some executives unaware. Every executive at some time has experi-
enced problems with his IT organization and systems, including delays
and unexpected costs in development projects, temporary or extended

1
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2 | IT Risk

loss of service, data loss or theft, processes made unnecessarily com-


plex by systems interfaces and limitations, inaccurate information from
redundant or “buggy” systems, and a myriad of other ills. Executives
have generally learned to perceive—and even tolerate—such episodes
as regrettably common but relatively limited in their impact on key
business metrics. Case studies of companies like Tektronix and Comair,
however, demonstrate how such perceptions no longer apply.
Comair, a $780 million subsidiary of Delta Air Lines, experienced
a runaway IT risk incident on December 24, 2004, when the com-
pany’s crew-scheduling system failed.1 An airline’s crew-scheduling
system is mission critical. Federal Aviation Administration safety reg-
ulations limit the number of hours any aircrew member can work in
a twenty-four-hour period. The scheduling system is what ensures
compliance with that strictly enforced regulation. Without its sched-
uling system, an airline does not fly.
Because of the holidays, December is always the busiest month
for U.S. airlines. December 2004 was busier than normal because
unusually bad weather forced airlines to cancel or reschedule many
flights, including 91 percent of all flights between December 22 and
December 24. No one at Comair knew that the crew-scheduling sys-
tem (which had been purchased from an external vendor) was capa-
ble of handling a maximum of only thirty-two thousand changes a
month.2 At about 10 p.m. on Christmas Eve, when Comair entered
one more flight change, exceeding the monthly capacity, the system
abruptly stopped functioning.
Comair technicians realized soon after, to their dismay, that the
system could not simply be restarted. The only solution was to re-
load the entire system from scratch as quickly as possible. The tech
team accomplished that task and relaunched the system late on
December 25, but by then Comair had problems assembling its
widely dispersed crews and aircraft where they were needed. The
airline didn’t resume normal operations until December 29.
As the company struggled to recover from the disaster, nearly two
hundred thousand stranded Comair passengers helplessly roamed

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Introduction | 3

airport terminals throughout the United States. Airlines were fully


booked for the holiday travel season, and there were few alternative
flights. Throughout the Christmas holiday, camera crews from local
and national television news outlets followed passengers through
those terminals, broadcasting travelers’ and Comair’s distress to the
American public.
Two weeks after the system failure, the U.S. Secretary of Trans-
portation announced an investigation into the incident. A week later,
the company’s president, Randy Rademacher, resigned. In addition to
the damage to the company’s reputation, its management, and its
customers, Comair’s revenue losses as a direct result of this incident
are estimated at about $20 million.3 In other words, the loss from this
single incident was nearly as high as the firm’s entire $25.7 million
operating profit for the previous quarter.
The company had planned, and delayed, replacement of the
scheduling system several times before it failed.4 Despite the out-
come, these decisions could be defended as rational business deci-
sions. The system had been running for years, and the likelihood of
a complete system failure—especially one that resulted from an
entirely unsuspected source—was apparently low. That the system
failed at a point in time when its failure was maximally damaging to
the company and its customers was extremely bad luck but hardly
predictable.
But something more was involved than an unfortunate decision
to defer an upgrade. Comair lacked a viable plan for the immediate
recovery of this mission-critical business process. Its executives failed
to plan for such a high-impact failure, however unlikely it seemed.
When the software went down, there was no backup system that
could be pressed into immediate service, no outsourcer on call and
ready to step in, no plan that could keep the company running man-
ually while the system was fixed.
In other words, it wasn’t just the computer system that failed—
it was Comair’s process for understanding and managing the busi-
ness consequences of IT risk. And making sure that an organization’s

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major corporate risks—IT or otherwise—are managed to an accept-


able level is the responsibility of the organization’s senior executives.
Perhaps that’s why it was the company’s president, not the CIO, who
departed in the wake of the incident.
The Comair case is about the risk of availability. The Tektronix
case is about agility—the ability to change rapidly with controlled
cost and risk. In the mid-1990s, executives at the $1.8 billion elec-
tronics manufacturer learned that their plans to divest a major busi-
ness unit had hit an unexpected snag.5 Key financial and manufac-
turing processes for three Tektronix business units were riddled
with undocumented interdependencies between critical systems.
Extracting one business’s systems from that tangled mass was like
removing a load-bearing wall from a building—it couldn’t be done
without major restructuring. The separated unit would require
duplicating nearly every one of Tektronix’s major systems (including
the sensitive corporate data they contained), as well as finding tech-
nicians to maintain the systems. The difficulty of spinning out a
division, with or without its IT systems, brought a focus to those IT
agility risks that had been present for years.
Tektronix arrived at this strategic dilemma gradually. For decades
the company’s IT department had extended existing systems, built
new stand-alone systems, and written software to link systems as
needed. Every new “solution” was an unconscious trade-off of long-
term agility in favor of short-term benefits. The problems inherent in
this approach weren’t immediately apparent to executives, but they
compounded over time, just as it takes time for unplanned, uncon-
trolled growth in a city to visibly overload roads, schools, sewers, and
support services.
By the early 1990s, Tektronix executives knew their IT systems
had problems. Changes took much longer to implement than they
should have and than executives would have liked. It was frustrat-
ingly difficult to get an integrated view of the company’s customers,
products, and orders. Business managers complained that IT support

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was getting worse and worse, and IT managers knew that the systems
were becoming more and more difficult to maintain. Extensive coor-
dination by smart support staff covering for system inadequacies was
so frequent that it produced a motto: “Five calls does it all.”
But these ongoing signs of agility risks seemed relatively low
impact. They were annoying, of course, but they were a more or less
normal part of the way business was done at Tektronix and at many
other companies. It was only when Tektronix executives tried to
break from the past that they saw the real threat those familiar an-
noyances posed.
The Tektronix and Comair cases are extreme in their conse-
quences, but they are not unique. Other events in multiple industry
sectors show that executives must learn to think of IT risk in terms
of serious business consequences:

• In mid-2005, CardSystems Solutions, Inc. reported that


unknown persons had gained unauthorized access to com-
puterized credit transactions for 40 million credit card
holders. A few weeks after the breach, CardSystems’ two
largest customers, Visa and MasterCard, terminated their
business with the company, which was soon after sold.6

• In 1996, a failed implementation of SAP’s enterprise


resource planning software at FoxMeyer, a $4 billion phar-
maceutical distributor, allegedly led to the company’s bank-
ruptcy. The company’s trustees filed suit against SAP (the
software vendor) and Accenture (the systems integrator for
the project), asking for $500 million in damages from each.
The case was settled out of court in 2005.7

• In December 2003, the United Kingdom’s Inland Revenue


put a new system for managing tax credits into production.
Preproduction testing had been limited to four weeks rather
than the planned twenty weeks because the project was

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6 | IT Risk

behind schedule. It is estimated that over £2 billion in


erroneous tax credits were paid out by the system before
errors were recognized and corrective measures taken.8

We could easily continue—there is no shortage of recent inci-


dents of this sort, and more are reported every week. IT has become
more and more central to business over the past twenty years, but
many enterprises have not adjusted their processes for making key
decisions about IT and IT risks. The result is risk incidents that have
three factors in common:

1. They involve significant harm to constituencies inside and


outside the enterprise that results from failure of IT systems
or controls on IT processes.

2. Increasingly, they involve public disclosure, resulting in


reputation damage and regulatory scrutiny.9 Such public
disclosure amplifies the consequences of IT risk, with
subsequent consequences sometimes far exceeding the
initial economic losses.

3. They expose failure to account for potential business conse-


quences in managing IT risks—in other words, they expose
a failure of general management, not just IT management.

Executives who invested—wisely—in IT as a strategic weapon


simultaneously increased the IT risk to their enterprises. By depend-
ing more on IT for key processes, competitive efficiencies, and links
to customers and suppliers, they increased their firms’ dependence
on smoothly functioning IT systems, as well as their vulnerability to
external threats.
Many managers do not yet understand the full implications of
this shift. To put it bluntly, management of IT risk has not kept pace
with the reality of IT risk. IT risk in many enterprises is still handled
as a technical issue and is largely ignored by business executives.
Even when business executives understand the strategic importance

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of IT to their enterprises, they often have not been able or willing to


make the hard trade-offs necessary to manage IT systems effectively.

The Causes of IT Risk


To understand what causes IT risk in organizations and how to man-
age it effectively, we undertook a set of research studies that combine
academic rigor with the practical insights we have each gathered in
over twenty years of working in and with IT organizations. More
than 50 firms participated in case studies, and more than 130 firms
participated in a survey associated with this endeavor. Executive
presentations with more than two thousand IT and non-IT execu-
tives have helped us refine our research findings and relate them to
real-world situations.
Our research shows that most IT risks arise not from technical or
low-level people issues but from the failure of the enterprise’s over-
sight and governance processes for IT. Such failures produce a series
of poor decisions and badly structured IT assets that are manifested as
ineffective IT governance, uncontrolled complexity, and inattention to
risk.10 In other words, most IT risk results not from technology itself
but from decision-making processes that consciously or uncon-
sciously ignore the full range of potential business consequences of IT
risk. Over time, as risk-blind actions accumulate and compound, the
conditions for disastrous, runaway risk incidents increase.

Ineffective IT Governance

Many of the risk factors we discuss throughout the book are


symptoms of a common condition: a history of ineffective IT gover-
nance (see “What Is IT Governance?”).
Inadequate IT governance—the absence of appropriate struc-
tures and processes for business involvement in IT investments and
decisions—paves the path to risk in two important ways:

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8 | IT Risk

1. Locally optimized decisions create enterprise risks. IT organi-


zations in many enterprises are organized and motivated
(for example, through reporting lines and responsibilities)
to be closer to the business organizations they serve and
to respond to requests from the business as quickly as
possible, rather than to take an enterprise view of IT deci-
sions. Although each locally optimized decision may seem
entirely justifiable and safe, the agility risks implicit in such
decisions compound over time to dangerously high levels,
as they did for Tektronix.

2. Without business involvement, IT managers can make incorrect


assumptions about which risks matter most to the business.
When markets, competitors, or corporate strategy change,
the IT organization may learn slowly, if at all, that basic

What Is IT Governance?

IT governance is defined as “specifying the decision rights and ac-


countability framework to encourage desirable behavior in using
IT.”a Just as in financial or corporate governance, IT governance is
embedded in formal structures that allocate rights and responsibili-
ties for decisions in certain IT domains (such as applications, archi-
tecture, and security) to appropriate business and IT executives.
Governance decisions are supported by processes for surfacing
information and driving resulting actions. In short, an IT governance
arrangement describes how an enterprise’s decisions related to IT
are made and enforced.

a. Peter Weill and Jeanne Ross, IT Governance: How Top Performers Manage IT Decisions Rights
for Superior Results (Boston: Harvard Business School Press, 2004), 2.

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business assumptions and standard operating procedures


must also change. The result is a gap between real and
perceived risks and controls, leading to overinvestment in
managing minor risks and underinvestment in more criti-
cal ones.

Effective IT governance is especially important in times of rapid


strategic change, when previously valid assumptions about what mat-
ters most (and why) are questionable—and rapid strategic change is a
fact of life in most industries today.

Uncontrolled Complexity

Complexity per se is not necessarily more risky than simplicity.


Modern automobiles are much more complex than automobiles
from the 1960s, but they are also generally safer, more reliable and
efficient, and of far better quality overall. But complexity without
solid engineering increases risk in many ways. Most important,
complex environments that are not carefully engineered tend to be
fragile. They have many moving parts, and the parts are prone to
break or function unpredictably, with equally unpredictable effects
on other business and technical systems. Such haphazardly complex
environments demand a great deal of knowledge and attention to
manage effectively, and those resources are scarce. The result is
increased risk.

Inattention to Risk

Inattention to risk encourages operational risks. Symptoms of


inattention include:

• Missing or inadequate knowledge. Layoffs, retiring personnel,


promotions, and reliance on external consultants reduce an
enterprise’s core knowledge and open the door to risk.

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10 | IT Risk

• Poor infrastructure management. Inadequate device manage-


ment and refusal to retire old, unreliable technologies lead
to high costs and failure rates and to long recovery times.

• Employee ignorance, negligence, or malfeasance. Employees


who do not know or care how to avoid risk and employees
bent on destructive or criminal acts create failures and
breakdowns of security and privacy.

• Systems that are blind to dangerous activities. Systems that fail


to detect or prevent dangerous activities abet management
inattention by removing a potential layer of automated
warning and protection. Automated controls are particularly
important when the enterprise allows key employees consid-
erable authority to act autonomously. For example, appro-
priate levels of automated controls at Barings Bank might
have detected the activities of Nick Leeson, whose unautho-
rized trades in violation of company rules lost $1 billion
over nine months and bankrupted the institution.11

Ineffective governance, uncontrolled complexity, and inatten-


tion to risk create an environment of pervasive IT risk. Pervasive risks
cannot be fully controlled by asking technicians to perform technical
tasks differently. The risks are intrinsic to the way the company does
business, not just to the way it manages IT. Further, risk factors rein-
force and compound one another, so addressing individual risks that
particular managers see does not address the full range of risks im-
plicit in a given situation.
In short, having an excellent IT staff is not enough to control IT
risk. Managing IT risk requires everybody involved to think differ-
ently. The CIO must make the business consequences of IT risk clear
to business executives and provide a decision-making environment in
which those executives can discuss and make decisions about IT risk
in business terms. Business executives must ensure that the CIO has

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Introduction | 11

implemented risk management and must actively participate in the


tough decisions and culture changes that IT risk management entails.

IT Risk as Business Risk and Business Value


Because IT risk is now business risk, with business consequences,
enterprises must change the way they manage it. Businesses can no
longer afford to assume that IT risks will be contained within the
walls of the IT department, or even of the enterprise. They must
replace technology-driven approaches and fragmented views of IT
risk with an integrated view that starts with an understanding of the
business risks and consequences that flow from IT decisions. Then
they must take action.
This is essentially what Tektronix did after its rude awakening to
IT risk in 1996. Led by the CFO and CIO, with strong support from
the CEO, Tektronix redesigned its business processes and replaced
its jumble of complex systems with an enterprise resource planning
package. The initiative demanded committed leadership to make the
case for change, convince skeptics to adopt standard processes, and
discipline remaining holdouts. Not only did the information systems
have to change—the undisciplined variety of business processes that
produced the risk-ridden systems morass had to change as well.
The process was painful—it took three years and about $55 mil-
lion to complete—but it was ultimately successful in many ways. Tek-
tronix was at last able to acquire and divest divisions flexibly. The
changes reduced other IT risks and improved business performance
significantly as well. More accurate information, delivered faster, en-
abled higher inventory visibility, faster credit approvals, and a five-
fold increase in the percentage of same-day shipments. In the end
executives had better information to support strategic decisions, and
more agility to implement those decisions.12

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12 | IT Risk

In our research we have encountered many companies that have


turned around dangerously risky situations by building IT risk man-
agement capabilities incorporating two key elements:

1. They have adopted an integrated view of IT risk that allows


them to make rational, informed trade-offs about IT risk in
business terms.

2. They place careful emphasis on three core disciplines for


managing risk: simplifying the IT foundation, creating a
risk governance process, and fostering a risk-aware culture.

These elements work together. Without an effective risk manage-


ment capability, enterprises cannot have useful conversations about
IT risk. Without a common language that conveys IT risks in busi-
ness terms, business executives cannot make informed decisions
about these risks.
Managing an integrated business view of IT risk via the three
core disciplines reduces IT threats while increasing business value
derived from IT. If IT risk is handled as a compliance or avoidance
issue, then it’s just a cost to be managed. But if IT risk is handled in
the right way, as business risk and capability, business value is cre-
ated in three ways. First, there are fewer fires to fight, and the enter-
prise can focus on more productive activities. Second, the IT foun-
dation is better structured and less costly, freeing resources for more
productive activities. Third, the enterprise can pursue valuable op-
portunities that other firms would consider too risky to attempt.

Structure and Intended Readers of This Book


Many books have been written about specific elements of managing
risk, in both business and IT. But, to our knowledge, this is the first
book to provide rigorous research-driven advice and tools for build-

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ing a comprehensive view of IT risk as business risk. As such, it


should be read by business executives and IT executives alike.
If you’re a business executive or board member, we provide ideas,
frameworks, and advice to help you meet your fiduciary responsibil-
ity of managing IT risks as effectively as you manage other risks.
If you’re an IT executive, we provide step-by-step advice and
tools to help you build an IT risk management capability. We pro-
vide information in a practical form to help you start the program,
find the right specialists for each element, and engage both business
and IT people in the right roles.
Chapter 1 presents our key framework linking IT risk and busi-
ness priorities. Contrary to the technical and compartmentalized way
in which most enterprises manage IT risk, we argue that IT risks are
best summarized in terms of four key business objectives: availabil-
ity, access, accuracy, and agility. Technical risks can be best managed
in terms of costs, benefits, and trade-offs among the business objec-
tives—the same way executives make all their key decisions.
Finding a way to discuss IT risks in natural business terms is only
the first part. Enterprises also must have the capability to identify,
prioritize, and address the risks they face. Chapter 2 starts the enter-
prise on this path with a discussion of the three core disciplines of
effective risk management:

1. A well-structured, well-managed foundation of IT assets,


people, and supporting processes

2. A well-designed risk governance process to identify, priori-


tize, and track risks

3. A risk-aware culture in which people understand causes and


solutions for IT risks and are comfortable discussing risk

Enterprises generally start with and emphasize one of these disci-


plines, but they must ultimately be capable in all of them. Over time, an
enterprise may choose to change its emphasis as its capabilities mature.

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Chapters 3–6 represent the heart of the book and offer a blue-
print for developing effective risk management capabilities. These
chapters have been written for IT executives, who will be responsible
for implementing the practices, and should be skimmed by business
executives, who will participate in the processes and charge their
CIOs with implementing those processes. Chapters 3–4 describe
how to improve the IT foundation of applications, infrastructure,
people, processes, and controls. In these two chapters, we describe
the IT risk pyramid and how executives can use it to manage the
right risks in the right order.
Chapter 5 shows how to establish the second core discipline, the
IT risk governance process. An effective IT risk governance process is
coordinated by a risk officer, conducted by managers in each func-
tional area, and overseen by executives at higher levels. The chapter
includes processes and tools to make risk governance effective.
The final risk discipline, a risk-aware culture, is the topic of chap-
ter 6. No process can be effective and no foundation can be protected
if the enterprise is afraid to talk about risk. A risk-aware culture starts
at the top with business executives who set direction, model risk-
aware decision making, and reward effective risk management behav-
iors. The goal is a culture in which risk is discussed openly across the
organization and actively managed to tolerable levels.
Chapters 7–9 bring the focus back to the business executives
who are so critical to the success of IT risk management. IT risk has
serious business consequences, and business executives have im-
portant roles to play in managing IT risk effectively.
Chapter 7 describes how to assess each discipline—the founda-
tion, risk governance process, and risk-aware culture—in your orga-
nization and bring each up to at least a competent level. Although
enterprises must become competent in all three disciplines as fast as
possible, they often choose one focal discipline as the rallying point
to continuously improve all three well beyond the competent stage.

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We present diagnostic tools to assess the pros and cons of different


focal discipline choices in your organization.
Chapter 8 is about looking forward to anticipate strategic risks.
Much risk management is about identifying and resolving risks in
the present or near future, but executives have a duty to make sure
that the enterprise is viable for the long term. Accordingly, in this
chapter we describe how to incorporate risk management into the
firm’s considerations of likely future strategic changes.
Chapter 9 concludes the book with a summary of key themes
and an executive call to action. It highlights the ten ways executives
can improve their IT risk management.

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Excerpted from IT Risk by George Westerman and Richard Hunter. Copyright George
Westerman and Gartner, Inc. All rights reserved. Harvard Business School Press, June 2007.